چکیده انگلیسی

Does the choice of exchange rate regime affect an economy's adjustment to real shocks? Exploiting the unpredictability and economic exogeniety of windstorms–hurricanes and typhoons–and earthquakes this paper assesses the often contrasting answers found in the theoretical literature. There is robust evidence that exchange rate flexibility helps an economy better adjust to real shocks. And consistent with the channels emphasized in the classic literature on exchange rates and shocks, differences in the behavior of the export sector help explain the different reactions between the two regimes.

مقدمه انگلیسی

Does the choice of exchange rate regime affect an economy's adjustment to real shocks? This question has long been at the center of the debate over optimal exchange rate regimes, and has spawned a now classic theoretical literature. Variations of standard arguments imply that nominal exchange rate movements can restore equilibrium faster in economies with rigid prices (Friedman, 1953, Mundell, 1961 and Poole, 1970). By depreciating the currency, the monetary authorities in a flexible rate regime can increase the domestic price of exports, helping to offset the effects of an adverse shock. Higher price levels can also reduce real wages, hastening the adjustment process. In contrast, after a negative shock in fixed rate regimes, output declines until wages and prices fall to their new equilibrium level, with the pace of adjustment determined by nominal rigidities.1
However, the many recent instances of macroeconomic instability suggest some important caveats to this classic literature. In part because of concerns about their commitment to price stability, very few central banks in developing countries may have the ability to effectively pursue countercyclical monetary policy (Kaminsky et al., 2004 and Frankel et al., 2002). Thus, an important component of the adjustment process in flexible rate regimes may be limited in practice. Also, prices may not be particularly rigid in many developing countries, making adjustment through the nominal exchange rate superfluous.
Moreover, fixed rate regimes can reduce exchange rate variability and lower transaction costs, thereby stimulating trade, investment and growth (Frankel and Rose, 2002). And depending on the balance sheet exposure of firms, nominal exchange rate movements can exacerbate the impact of real shocks. Therefore, some have argued that a credible fixed rate regime can be appropriate even for a developing country facing real shocks. The literature on exchange rate choice is extensive, and helpful surveys include Calvo and Mishkin (2003), Corden (2002) and Dornbusch (2001).
Although the relationship between the choice of exchange rate regime and adjustment to real shocks has generated contrasting theoretical predictions, and remains a key question among macroeconomists and policy makers, systematic empirical testing has been sparse, in part for very good reasons. The exchange rate regime is a policy choice that remains little understood, and selection bias can plague attempts to discriminate between the various predictions. Policy makers may choose a particular regime because of the shocks that they expect to receive. Or the choice of regime may influence the types of shocks that a country experiences. In both instances inference is likely to be misleading, and the identification of shocks may hinge on potentially implausible assumptions about the policy maker's information set.
Even the few empirical studies that have provided important insights into this relationship using the terms of trade as a source of shocks are not immune from these concerns (Broda, 2001 and Edwards and Levy-Yeyati, 2003). The choice of exchange rate regime can influence an economy's trade patterns and level of openness, and thus, the frequency and intensity of terms of trade shocks. Alternatively, a policy maker may choose a particular regime based on expectations about the costs of terms of trade fluctuations. Both these possibilities can affect inference.
Using data on natural disasters such as windstorms–hurricanes, tornadoes, typhoons–and earthquakes, this paper develops stylized facts and empirical tests to help evaluate the contrasting theoretical predictions about the exchange rate regime and the economic adjustment to real shocks.2 Natural shocks cause extensive damage to physical and human capital, and are easily observable, yet highly unpredictable. There is of course the celebrated 1975 Haicheng Earthquake in China, where based on abnormal animal behavior an earthquake was correctly predicted sufficiently in advance to reduce casualties. But the Haicheng Earthquake is so celebrated because it remains anomalous.3 Most importantly, the scientific community generally agrees that natural shocks like windstorms and earthquakes are not caused by economic decisions, especially those relating to exchange rate policy (Benson and Clay, 2004).4
These attributes make natural shocks good candidates to help identify the role of the exchange rate regime in the adjustment process. That said, while they are unpredictable, windstorms and earthquakes do cluster within particular geographic areas. And although I have not seen this claim made, it is possible that for a small subset of countries, their general susceptibility to natural shocks may influence both exchange rate policy and the response to the shock. But general susceptibility is an observable that can be included in the estimation framework, reducing the possibility of bias.
Even after accounting for geographic clustering, these shocks remain mostly low probability unpredictable events for many countries, and are unlikely to be a factor in exchange rate policy. The Caribbean is notoriously hurricane prone, yet an Atlantic hurricane on average has struck one of these islands just 7 times in the last 100 years. Likewise, after the catastrophic earthquake in 1755, Lisbon has experienced little seismic activity since.
The results provide broad support for the idea that in developing countries, exchange rate flexibility can help an economy better adjust to real shocks. The adjustment mechanisms also appear to be consistent with that identified in the classical theoretical literature. Therefore, while a credible fixed rate regime can be appropriate even for a country facing real shocks, at least based on the results in this paper, there are likely to be significant costs associated with such a policy. Indeed, if natural disasters resemble other real economic shocks–plausible, but I think still an open question–then the costs of fixed exchange rate regimes can be quite high in economies that frequently experience large adverse shocks.
In particular, fixed exchange rates do no better than flexible regimes, and in most cases perform considerably worse when these shocks occur. Over a 3 year period, output growth is on average about 1.6 percentage points higher after a windstorm in flexible regimes. The mean response in fixed rate regimes is significantly smaller—only about 0.24 percentage points. Earthquakes produce a similar pattern when examined over a 3 year horizon. An earthquake registering 6.5 on the Richter scale–the mean level in the sample–is associated with a 2.37 percentage point increase in output growth in flexible rate regimes; the impact is about 50% less in fixed rate regimes.
The results on the adjustment channels are equally stark. One year after a windstorm, the real value of export growth is about 7.5 percentage points higher than otherwise in flexible rate regimes. In contrast, export growth declines by 1.3 percentage points in fixed rate regimes, and a positive export response is observed only 2 years after the shock. And over a three horizon, the positive export response in flexible rate regimes is about 42% larger than in fixed rate economies. That is, consistent with adjustment through a depreciation of the nominal exchange rate—the export response in flexible rate regimes is both faster and larger.
This paper is organized a follows. Section 2 discuses the empirical framework and data, while Section 3 presents the main results; Section 4 focuses on the adjustment mechanism and Section 5 concludes.

نتیجه گیری انگلیسی

Windstorms and earthquakes disrupt economic activity, are easily observable, and are inherently unpredictable. This paper has exploited these features to understand better the relationship between the choice of the exchange rate regime and the economic adjustment to real adverse shocks in a large panel of developing countries. There is robust evidence that exchange rate flexibility can help mitigate the impact of these shocks. Across a wide variety of specifications, recovery after these events is significantly faster and larger in flexible rate regimes. The evidence also indicates that the response of the export sector in flexible rate regimes is again both bigger and faster—consistent with the classic adjustment through a depreciation of the exchange rate. In both regimes however, fiscal policy appears to be equally procyclical.
If one is willing to believe that natural disasters resemble other real economic shocks–a defensible belief given the nature of these shocks and the similarities between these results and those obtained using the terms of trade in the literature–then this evidence suggest that the choice of exchange rate regime can have large consequences for economies the experience adverse real shocks. And the classic prescription of exchange rate flexibility to counter the effects of real shocks in developing countries can be welfare improving, especially for those economies where the shocks are large and frequent. Of course, the reaction to real shocks is one of several factors when deciding upon optimal exchange rate policy, and these results add to rather than settle the debate.
Indeed, these findings should be interpreted with some care. The observability and unpredictability of natural disasters are helpful in identifying the role of the exchange rate regime in the adjustment process, but the economic damage caused by these shocks can depend on the existing level of social vulnerability (Pielke and Pielke, 1997). Social vulnerability remains a nebulous concept at the macro level—building codes, construction standards and the like. And although I have included many plausible macroeconomic controls, these results could still be biased to the extent that the unobserved component of social vulnerability is correlated with the choice of exchange rate regime.
That said, the long run implications of the different adjustment mechanisms across exchange rate regimes is an important area of future research. Small developing countries frequently experience adverse real shocks. Does the bigger and faster export response to these shocks significantly impact long run development in flexible rate regimes? Separately, fiscal policy appears to be equally procyclical across exchange rate regimes. But because of the different output responses, does the reaction of long term debt levels to real shocks differ across regimes?